Covid-19 and interest rates

“We Just Witnessed The Fastest Stock Market Correction on Record” was Friday’s attention grabbing headline, after the S&P 500 dropped more than 10% in just six days. Comparisons to 1987’s Black Monday, the Great Depression and the Great Financial Crisis were (and continue to be) everywhere. It is tempting to dismiss stock market gyrations as isolated incidents that excite the financial community while the rest of the world moves on. However, in this case the Coronavirus truly is a “black swan” event befalling the real economy. Already, the effects have been tangible: quarantines, empty shelves in supermarkets due to stockpiling, and cancelled mass events.

Estimates of the potential impact on GDP growth are highly uncertain and should be taken with not just a pinch but a shovel of salt. But a knock to global GDP growth of one to two percentage points is probably not too far off the mark. As a result, Europe and the US are highly likely to drift into recession. In light of this, the shift in market sentiment to “risk off” – which drove the US 10-year treasury yield to an all-time low of 1.03% – is understandable.

A temporary dent to economic growth or the beginning of a crisis?

Closely linked to the question of how bad it’s going to be is how long any downturn will last. Broadly, there appear to be two ways the Covid-19 pandemic could play out. In the less severe scenario, at worst we would be in for two quarters of negative GDP growth, i.e. a technical recession, with a strong bounce in activity once the virus is under control. Afterwards, the world economy would be back on track. The other, more worrisome, outcome would see a prolonged global slump. In such a scenario Covid-19 is the black swan that derails the global economic system from its current growth trajectory to a significantly lower one.

There is little doubt that in the latter scenario, central banks would once more respond with extraordinary monetary stimulus. Those that have room to do so will cut rates, and quantitative easing will certainly be on the menu in all developed economies. Yet another extended period of rock-bottom interest rates would follow a severe and lasting Covid-19 induced downturn. But what if economic growth picks up swiftly once it is clear that the virus has been contained? One could argue that in such a scenario – where the shock is transitory – central banks shouldn’t react at all. Policymakers are hence facing a conundrum: act now and with force at the risk of over-reacting to a temporary shock, or adopt a wait-and-see approach that would mean too little too late if we are indeed headed towards a significant economic crisis?

Continue reading article…

This Week’s Most Read

Latest IFA Magazine Podcast Episodes

Keep updated on the most important financial events 

Make sure you are an informed

wealth professional..

Adblock Blocker

We have detected that you are using

adblocking plugin in your browser. 

IFA Magazine